Principles of risk management and insuarance 10th by george rejda chapter 06

Rate making• Rate making refers to the pricing of insurance – Total premiums charged must be adequate for paying all claims and expenses during the policy period – Rates and premiums are

Chapter 6

Insurance

Company

Operations

• Rate making

• Underwriting

• Production

• Claim settlement

• Reinsurance

• Investments

Rate making

• Rate making refers to the pricing of insurance

– Total premiums charged must be adequate for paying all claims and expenses during the policy period

– Rates and premiums are determined by an actuary,

using the company’s past loss experience and industry statistics

• Underwriting refers to the process of selecting, classifying, and pricing applicants for insurance

– The objective is to produce a profitable book of business

• A statement of underwriting policy establishes policies that are consistent with the company’s objectives, such as

– Acceptable classes of business

– Amounts of insurance that can be written

• A line underwriter makes daily decisions concerning the

acceptance or rejection of business

• There are three important principles of

underwriting:

– The underwriter must select prospective insureds

according to the company’s underwriting standards

– Underwriting should achieve a proper balance within

each rate classification

• In class underwriting, exposure units with similar loss-producing characteristics are grouped together and charged the same rate

– Underwriting should maintain equity among the

policyholders

• Underwriting starts with the agent in the field

• Information for underwriting comes from:

– The application

– The agent’s report

– An inspection report

– Physical inspection

– A physical examination and attending physician’s report

– MIB report

• After reviewing the information, the underwriter can:

– Accept the application

– Accept the application subject to restrictions or modifications

– Reject the application

• Production refers to the sales and marketing

activities of insurers

– Agents are often referred to as producers

– Life insurers have an agency or sales department

– Property and liability insurers have marketing

departments

• An agent should be a competent professional with

a high degree of technical knowledge in a

particular area of insurance and who also places

the needs of his or her clients first

Claim Settlement

• The objectives of claims settlement include:

– Verification of a covered loss

– Fair and prompt payment of claims

– Personal assistance to the insured

• Some laws prohibit unfair claims practices, such

as:

– Refusing to pay claims without conducting a reasonable investigation

– Not attempting to provide prompt, fair, and equitable

settlements

Offering lower settlements to compel insureds to institute

Claim Settlement

• The claim process begins with a notice of loss

• Next, the claim is investigated

– A claims adjustor determines if a covered loss has

occurred and the amount of the loss

• The adjustor may require a proof of loss before the claim is paid

• The adjustor decides if the claim should be paid or denied

– Policy provisions address how disputes may be

resolved

• Reinsurance is an arrangement by which the

primary insurer that initially writes the insurance

transfers to another insurer part or all of the

potential losses associated with such insurance

– The primary insurer is the ceding company

– The insurer that accepts the insurance from the ceding company is the reinsurer

– The retention limit is the amount of insurance retained

by the ceding company

– The amount of insurance ceded to the reinsurer is

known as a cession

• Reinsurance is used to:

– Increase underwriting capacity

– Stabilize profits

– Reduce the unearned premium reserve

• The unearned premium reserve represents the unearned portion of gross premiums on all outstanding policies at the time of valuation

– Provide protection against a catastrophic loss

– Retire from business or from a line of insurance or

territory

Exhibit 6.1 Summary of Key Features of

the Terrorism Risk Insurance Act of 2002

• There are two principal forms of reinsurance:

– Facultative reinsurance is an optional, case-by-case method that is used when the ceding company receives an application for

insurance that exceeds its retention limit

– Treaty reinsurance means the primary insurer has agreed to cede insurance to the reinsurer, and the reinsurer has agreed to accept the business

• Under a quota-share treaty, the ceding insurer and the reinsurer agree

to share premiums and losses based on some proportion

• Under a surplus-share treaty, the reinsurer agrees to accept insurance

in excess of the ceding insurer’s retention limit, up to some maximum amount

• An excess-of-loss treaty is designed for catastrophic protection

• A reinsurance pool is an organization of insurers that underwrites insurance on a joint basis

Reinsurance Alternatives

• Some insurers use the capital markets as an

alternative to traditional reinsurance

• Securitization of risk means that an insurable risk

is transferred to the capital markets through the

creation of a financial instrument, such as a

futures contract

• Catastrophe bonds are corporate bonds that

permit the issuer of the bond to skip or reduce the interest payments if a catastrophic loss occurs

• Because premiums are paid in advance, they can be

invested until needed to pay claims and expenses

• Investment income is extremely important in reducing the

cost of insurance to policyowners and offsetting

unfavorable underwriting experience

• Life insurance contracts are long-term; thus, safety of

principal is a primary consideration

• In contrast to life insurance, property insurance contracts

are short-term in nature, and claim payments can vary

widely depending on catastrophic losses, inflation, medical

Exhibit 6.2 Growth of Life Insurers’

Assets

Exhibit 6.3 Asset Distribution of

Life Insurers 2004

Exhibit 6.4 Investments of Property

and Casualty Insurers, 2004

Other Insurance Company

Functions

• The electronic data processing area maintains

information on premiums, claims, loss ratios,

investments, and underwriting results

• The accounting department prepares financial

statements and develops budgets

• In the legal department, attorneys are used in

advanced underwriting and estate planning

• Property and liability insurers provide numerous

loss control services